Wray: MMT Primer – Blog #5

Government Budget Deficits are Largely Nondiscretionary

The Case of the Great Recession of 2007

by L Randall Wray

http://neweconomicperspectives.org (July 04 2011)

In previous blogs, we have examined the three balances identity and established that the sum of deficits and surpluses across the three sectors (domestic private, government, and foreign) must be zero. We have also attempted to say something about causation because it is not enough to simply lay out identities. We have argued that while household income largely determines spending at the individual level, at the level of the economy as a whole it is best to reverse that causation: spending determines income.

Individual households can certainly decide to spend less in order to save more. But if all households were to try to spend less, this would reduce aggregate consumption and thus national income. Firms would reduce output, thus, would lay-off workers, cut the wage bill, and thereby lower household income. This is Keynes’s well-known “paradox of thrift” – trying to save more by cutting consumption will not increase saving. We’ll have more to say about that in later MMP blogs.

However, there is an issue of immediate interest given the deficit hysteria that has gripped the United States (as well as many other countries). In the aftermath of the global financial crisis (GFC), social spending by government (for example, on unemployment compensations) has risen while tax revenues have collapsed. The deficit has grown rapidly leading to widespread fears of eventual insolvency or bankruptcy. Those, too, are issues for later blogs. The implication of growing deficits has been attempts to cut spending (and perhaps to increase taxes) to reduce deficits. The national conversation (in the US, the UK, and Greece, for example) presumes that government budget deficits are discretionary. If only the government were to try hard enough, it could slash its deficit.

As I have argued in previous blogs (particularly in responses to questions), however, anyone who proposes to cut government deficits must be prepared to project impacts on the other balances (private and foreign) because by identity the budget deficit cannot be reduced unless the private sector surplus or the foreign surplus (flip side to the domestic current account deficit) is reduced. In this blog, let us look at the rise of the US government budget deficit since the GFC hit. We will ask whether the deficit has been, and might be, under discretionary control – if not then that raises questions about the attempts by deficit hysterians to reduce deficits.

In the aftermath of the Great Recession of 2007, the US federal government budget moved sharply to large deficits. While many attributed this to various fiscal stimulus packages (including bail-outs of the auto industry and Wall Street), the largest portion of the increase in the deficit came from automatic stabilizers and not from discretionary spending. This is easily observable in the graph below which shows the rate of growth of tax revenues (mostly automatic), government consumption expenditures (somewhat discretionary) and transfer payments (again mostly automatic) relative to the same quarter of the previous year:

In 2005 tax revenues were humming, with a growth rate hitting fifteen percent per year – far above GDP growth – hence, reducing non-government sector income – and faster than government spending, which grew just above five percent. Such fiscal tightening (called fiscal drag) often is followed by a downturn – and the downturn that accompanied the GFC was no exception. When it came, the budget deficits increased, mostly automatically. While government consumption expenditures remained relatively stable over the downturn (after a short spike in 2007-2008), the rate of growth of tax revenues dropped sharply from a five percent growth rate to a ten percent negative growth rate over just three quarters (from Q4 of 2007 to Q2 of 2008), reaching another low of minus fifteen percent in Q1 of 2009. Tax receipts quite simply fell off a cliff.

Transfer payments grew at an average rate of ten percent since 2007, with the higher rate in part due to the rotten economy. Decreasing taxes coupled with increased transfer payments automatically pushed the budget into a larger deficit, notwithstanding the flat consumption expenditures. The automatic stabilizer – and not the bailouts or stimulus – is the main reason why the economy did not go into freefall as it had in the Great Depression of the 1930s. As the economy slowed, the budget automatically went into a deficit putting a floor on aggregate demand. With countercyclical spending and pro-cyclical taxes, the government’s budget acts as a powerful automatic stabilizer: deficits increase sharply in a downturn.

The expansion before the GFC had been led (mostly) by the 2000s housing boom, during which households borrowed (and spent) on an unprecedented scale. We already visited the three balances that demonstrated the private sector taken as a whole deficit spent for almost a decade in the lead-up to the GFC. In the Clinton boom, about half the deficit spending was by firms; however, in the 2000s boom, it was entirely the household sector that spent more than its income. Both the Clinton boom and the 2000s boom caused the budget deficit to fall (and to actually move into a large surplus during the Clinton years).

Since the crash, the household sector has retrenched (as it always does in recession), and saving remains high. Slow growth has been the major cause of the rapidly growing budget deficit – and the slow growth, in turn, is due to a high propensity to save by the retrenching household sector. See the next graph (thanks to Dimitri Papadimitriou of the Levy Economics Institute for providing the next two graphs to me):

What we see is a rather remarkable reduction of household saving on trend since the mid-1980s. The cause is beyond the scope of this blog. But the flip-side to that has been the rise of household debt. That trend turned around sharply after the GFC, with households saving like it was 1992 all over again. Given loss of jobs and stagnant incomes (at best) for most Americans, the notion that the household propensity to spend will sharply reverse course seems unlikely.

As we discussed above, shrinking the government’s deficit will require either that the private sector spend more relative to its income or that the US current account deficit fall sharply. But households are still heavily indebted and indeed more and more homeowners are falling “underwater” – so the likelihood that they will drop saving back down to the two to three percent range we saw in the 2000s seems unlikely. (Note that saving as a percent of disposable income is not exactly the same as the household balance that goes into our three sector balance equation. That is why although this is a small positive saving number, in the sectoral balances equation households actually spent more than their income. See the note at the end of this blog for the wonky stuff.)

Another possibility is a domestic private business sector boom. That, too is unlikely with high unemployment and depressed domestic demand and stagnant sales – investment by firms is not going to grow that much. (I won’t go into it here, but there is a lot of evidence that “investment-led booms” are really residential housing investment booms – housing construction is included in investment numbers – and there is little chance that we will see a housing construction boom in the near future.)

The final possibility is the foreign sector. The next graph shows US imports and exports on current account.

Imports are running around eighteen percent of GDP (rebounding sharply since the GFC) and exports are at fourteen percent of GDP – so exports are up, but imports are climbing a bit faster (this difference is mostly due to oil). While it is true that the US current account balance has become less negative in recent months, much more movement will be required to actually get to positive territory (more than three percent of GDP of adjustment would be required). Note that the last time we actually had a positive current account balance was in the Bush, Sr, recession – two decades ago.

Remember, to reduce the government sector deficit from the current nine percent or so of GDP toward balance will require some combination of a private sector movement toward deficit and a current account movement toward surplus amounting to a total of nine percentage points of GDP. That is huge. The problem is that actually trying to balance the budget through spending cuts or tax increases could reduce economic growth (I think it will actually cause a sharp downturn, but I do not need to make that case). Lower economic growth could conceivably reduce our current account deficit – by making Americans too poor to buy imports, by lowering US wages and prices to make our exports more competitive, and by reducing the value of the dollar. Note that all of those are painful adjustments for Americans. And it might not work, because it requires the US to slow without that affecting the global economy – if it also slows, US exports will not increase.

Now, deficit warriors insist that cutting government will induce faster growth of the private sector. If that were true, it actually makes it easier to reduce the budget deficit – as the private sector’s balance worsens toward deficit. On the other hand, more rapid growth will probably cause deterioration of the current account deficit (our imports will rise, our wages and prices will not fall, and the dollar could gain strength). That, in turn, must be matched by some combination of private sector and government sector movements toward deficits. The US has a higher propensity to import than do our trading partners – what that means is that if we grow at about the same rate as the rest of the world, our imports grow faster than our exports.

So, to balance the government’s budget we need to grow faster, but faster growth will probably increase our current account deficit so that the three balances identity will imply either that our private sector returns to excessive spending (as it did for the past decade) or that the government’s deficit cannot be reduced. It is something of a Hobson’s choice – with no morality implied – because what appears to be a “free choice” of reducing the budget deficit through faster growth means we actually are accepting bigger household debts and a bigger current account deficit.

That is the problem with analysis and policy recommendations that do not take account of the three balances – they ignore what is implied for the other balances.

Let us summarize the points. First, the three balances must balance to zero. This implies it is impossible to change one of the balances without having a change in at least one other. Second, at the aggregate level, spending (mostly) determines income. A sector can spend more than its income, but that means another spends less. While we can take government spending as more-or-less discretionary, government tax revenue (it is equivalent to its income) depends largely on economic performance. Chart 1 above showed that tax receipt growth is highly variable, moving pro-cyclically (growing rapidly in boom and collapsing in slump).

Government can always decide to spend more (yes, it is politically constrained), and it can always decide to raise tax rates (again, given political constraints), but it cannot decide what its tax revenue will be because we apply a tax rate to variables like income and wealth that are outside government control. And that means the budgetary outcome – whether surplus, balanced, or deficit – is not really discretionary.

Turning to our foreign sector, exports are largely outside the control of the US (we say they are “exogenous” or “autonomous to US income”). They depend on lots of factors, including growth in the rest of the world, US exchange rates, trade policy, and relative prices and wages (US efforts to increase exports will almost certainly lead to responses abroad). It is true that economic outcomes in the US can influence exports (as discussed, slower US growth can slow global growth) – but impacts of policy on exports are loose.

On the other hand, US imports depend largely on US income (plus exchange rates, relative wages and prices, and trade policy; again, if the US tried to reduce imports this would almost certainly lead to responses by trading partners that are pursuing trade-led growth). Imports are largely pro-cyclical, too. Again, our current account outcome – whether deficit, surplus, or balanced – is also largely nondiscretionary.

What is discretionary? Domestic spending – by households, firms, and government – is largely discretionary. And spending largely determines our income. Sectoral balances, however, should be taken as mostly nondiscretionary because they depend in very complex ways on the discretionary variables plus the nondiscretionary variables and on the constraints imposed by the macro identity. It makes most sense to promote spending that will utilize domestic resources close to capacity, and then let sectoral balances fall where they may. As we will argue in coming months, the best domestic policy is to pursue full employment and price stability – not to target arbitrary government deficit or debt limits, which are mostly nondiscretionary, anyway.

Note 1: The main differences between the personal saving rate and the household net saving as a percent of GDP are the following (thanks to Scott Fullwiler):

1. Household net saving is as a percent of GDP, whereas personal saving rate is as a percent of disposable income

2. Household net saving subtracts all household spending, including consumption and residential investment, whereas personal saving only subtracts consumption spending

A few additional smaller differences for the really wonky:

1. Household net saving adds an allowance for household capital consumption (that is, depreciation), personal saving doesn’t,

2. Household net saving imputes insurance and pension reserves to households from the government sector, personal saving doesn’t, and

3. Household net saving includes wage accruals less disbursements from businesses to households, personal saving doesn’t.

Note 2: Thanks to the MMT gang. You know who you are.

http://neweconomicperspectives.org/2011/07/government-budget-deficits-are-largely.html

Hardball Trump Regime Tactics Against China Doomed to Fail

by Stephen Lendman

Global Research (May 23 2019)

https://www.globalresearch.ca/wp-content/uploads/2018/05/china-US.jpeg

Washington’s geopolitical agenda is based on the notion that it can prevail against other nations by pressuring, bullying, warning, and intimidating them to bow to its interests.

It works against some countries, by no means not all, notably not in dealings with Iran, Venezuela, Cuba, for the most part, Russia, most of all not China.

It’s a growing power, not about to sacrifice the development of its long-term economic, industrial, technological, and defense aims.

Sino/US trade negotiations broke down over unacceptable Trump regime demands Beijing won’t agree to no matter how many rounds of talks are held.

On Tuesday, China’s envoy to the US Cui Tiankai said

 

If we review the process of trade talks between us over the last year or so, it is quite clear (that the) US, more than once, (not China) changed its mind overnight, and broke the tentative deal already reached.

 

As a result, Beijing is in “no rush” to restart talks. It’s prepared to suspend them if Trump regime negotiators aren’t “prepared to be realistic”, according to analysts quoted by the South China Morning Post.

Chinese Academy of Social Sciences’ Tao Wenzhao said:

 

There is no need to get into frantic calculations about when (Treasury Secretary Steve Mnuchin) will come (to Beijing for further talks) if the US continues to lack sincerity.

 

According to International Relations Professor Jia Qingguo,

 

The standoff should last for a while because the US has refused to make even the slightest compromise – to a point that is somewhat unreasonable.

 

It’s how Washington virtually always operates. It doesn’t negotiate. It demands, why two Kim Jong-un/Trump summits failed to reach agreement. The Trump regime remains unbending, making on unacceptable demands in return for empty promises.

The tactics failed with North Korea, jeopardizing future talks. Eleven rounds of Sino/US trade left both countries at an impasse because Trump regime officials are unbending, Beijing not about to yield to their unacceptable demands.

On Tuesday, President Xi Jinping said “we are now embarking on a new Long March, and we must start all over again” – referring to the protracted struggle between Mao Zedong and Zhou Enlai vs US supported Chiang Kai-shek’s nationalist forces, ending with the Red Army’s triumph, the forerunner of the People’s Liberation Army.

Xi’s remarks reflect the Sino/US trade talks standoff, no near-term resolution in prospect. While not mentioning the impasse directly, he indicated that there may be hardships ahead because of the worsening external environment at a time China’s economy is slowing.

On Monday, the official Xinhua News Agency said China “has been standing tall in the East for the last seventy years”, adding:

 

It has never lowered its head and it has never feared anyone. History will prove again that bullying and threats by the US will not work.

 

According to an unnamed source, “China is ready to fight a protracted trade war” if the Trump regime remains unbending.

International relations expert Jin Canrong suggested that China could retaliate against its toughness by banning exports of rare earth minerals to the US its tech companies rely on.

China accounts for about ninety percent of world production, a weapon it can use against the US if it pushes things too far, the direction it took by blacklisting tech giant Huawei and its affiliates, shutting them out of the US market, pressuring its allies to do the same thing, maybe intending similar action against other Chinese companies.

Beijing holds around $1.1 trillion of US Treasuries, down from its 2013 $1.3 trillion peak. It could continue reducing its holdings even though taking this action could lower their value.

It’ll clearly implement what it considers appropriate countermeasures in response to unacceptable US actions. Toughness cuts both ways, hurting both parties, Xi signaling China is willing to sustain pain in its quest to achieve objectives it won’t sacrifice to US demands.

In separate commentaries this week, China’s Global Times explained the following:

 

 

Freezing US tech exports to China’s Huawei, including software, chips, and Google’s Android open-source platform, won’t “stifle” the company’s operations, the impact to be “limited” because it prepared for possible adverse scenarios aimed at giving corporate America a competitive advantage.

 

Huawei’s founder and CEO Ren Zhengfei explained that US bias forced the company to develop “backup products” to deal with what’s going on now, adding:

 

Huawei will defeat the challenges created by the US supply ban. Although the US excels at high technology, the industry will not kneel before Washington.

 

On Tuesday, Bloomberg News reported that plans to blacklist Huawei from the US market were made months earlier, postponed so as not to disrupt trade talks, the action taken in response to the current impasse.

It’s a counterproductive strategy, falsely believing toughness can get Beijing to yield, clearly showing little understanding of its resolve not to do anything jeopardizing its long-term aims, even it takes a protracted struggle.

According to a South China Post “exclusive” report, the US Senate’s South China Sea and East China Sea Sanctions Act “proposes sanctions (on Beijing) for involvement in (what it calls) ‘illegal’ activities in (the) South and East China seas”, adding:

 

If passed by both houses and signed into law by Trump, it would authorize “seizure of US-based (Chinese) assets of those developing projects in areas contested by Asean members” – on the phony pretext of saying Beijing’s “actions or policies…threaten the peace, security or stability” of South China Sea areas contested by Southeast Asian nations.

 

Similar legislation was introduced in 2017, never reaching the Senate floor for a vote. Bipartisan supporters of the measure hope to make it US law this year.

Going this far will worsen bilateral relations, perhaps putting resolution of trade differences out of reach any time soon, jeopardizing them altogether as long as Trump regime hardball tactics persist.

The only solution to bilateral differences is compromise, short of demanding China sacrifice its long-term aims to US interests – what it surely won’t agree to.

The alternative is continued impasse, adversely affecting both countries and the global economy.

_____

Award-winning author Stephen Lendman lives in Chicago. He can be reached at lendmanstephen@sbcglobal.net. He is a Research Associate of the Centre for Research on Globalization (CRG)

His new book as editor and contributor is titled Flashpoint in Ukraine: US Drive for Hegemony Risks WW III (2014)

Visit his blog site at sjlendman.blogspot.com.

Disclaimer: The contents of this article are of sole responsibility of the author(s). The Centre for Research on Globalization will not be responsible for any inaccurate or incorrect statement in this article.

Copyright (c) Stephen Lendman, Global Research, 2019

https://www.globalresearch.ca/hardball-trump-regime-tactics-against-china-doomed-fail/5678324

Fire the Nutcases Leading Us to War

by Eric Margolis

https://ericmargolis.com (May 18 2019)

President Donald Trump claimed this week that he does not want war with Iran. If he really believes this, the president ought to look into what his subordinates are doing.

Among their bellicose actions are deployment of the Abraham Lincoln CVN-72 carrier task force to the coast of Iran, massing a strike package of B-52 heavy bombers in Qatar, just across the Gulf from Iran, positioning more US warplanes around Iran, readying a massive cyber attack against Iran, and trying to stop the export of Iranian oil, upon which its economy depends.

Plus repeated attempts to overthrow the government in Tehran – something the US already did very skillfully in 1953.

If all this is not war, according to Trump, then what is? It’s war by another name. Just what the US did to Cuba, Iraq, Sudan, North Korea, Nicaragua, Syria, and, since 1979, Iran. Like a shark, the US warfare state has to keep moving. So it finds threats popping up all over.

The latest alleged grave “threat” to America’s security was an ancient wooden dhow. Spotted by US satellites, this decrepit old sail-powered tub was claimed by Washington war promoters, led by the enragé John Bolton, to be carrying Iranian missiles. What unbelievable rubbish.

Many moons ago, I used to oversee dhows based in Dubai smuggling expensive Western luxury goods and small gold “ten tola” bars into India and Iran. They would dodge Indian and Pakistani patrol boats; if caught, “baksheesh” (bribes) were paid. Some of the smuggled goods even found their way into the Soviet Union, via caravans through Afghanistan.

All this was worthy of Sinbad the Sailor and the Arabian Nights. Great fun and profitable, but hardly of any strategic consequence. But now, Washington’s war-mongers claim the dhows will threaten “US interests” in the Gulf region. “US interests” are, of course, whatever and wherever Washington says they are.

This is yet another charade that will be amplified by the tame US media and gobbled up by the credulous public unsure if the Gulf is off Texas or Iran. It joins the huge lies about World War One – “Belgian babies spitted to German bayonets” – Iraqi weapons of mass destruction, anthrax attacks, and Saddam’s “drones of death”. Some cynics would add 9/11 and Osama bin Laden to the cast of manufactured villains.

We now know that all the reasons cited for attacking Iraq in 2003 where false. Pure lies. War propaganda. President George W Bush, Dick Cheney, and Tony Blair led us into a war by a campaign of lies that fed off one another. Media that supported the war with false news was equally guilty.

Yet we still see, for example, the Murdoch-owned media, New York Times, and Washington shamelessly promoting more war in the Mideast. US media has made little progress since the yellow journalism era of William Randolph Hearst. As the great Mark Twain said:

 

If you don’t read the daily newspapers you are uninformed. If you do read them, you are misinformed.

 

Which leads us to ask the question: given all these lies, is it not time for us to begin questioning the official narrative about World War Two?

Trump is playing with fire by making threats against Iran, Syria, Venezuela, Libya, Cuba, North Korea, and China. He appears well on the way to a major war by either plan or accident. He is provoking and trifling with two major, nuclear-armed world military powers, Russia and China. Instead of capable diplomats, Trump keeps consorting with men of low character and even lower knowledge. It’s like the hostess who will never invite to her party another woman who is younger and more attractive.

Copyright Eric S Margolis 2019

https://ericmargolis.com/2019/05/fire-the-nutcases-leading-us-to-war/

How Trump’s “America First” Trade Strategy …

… is Accelerating America’s Decline

by Marshall Auerback, a market analyst and commentator. Produced by Economy for All, a project of the Independent Media Institute

Zero Hedge (May 23 2019)

The United States has increased tariffs on $200 billion worth of Chinese products to 25 percent, and Beijing has responded in kind on $60 billion worth of American goods. More tit for tat appears to be on the way: the Trump administration is now openly deliberating whether to impose additional tariffs on a further $325 billion of Chinese goods exported to the United States. National security concerns are also being increasingly invoked: Not only is Huawei, the Chinese telecommunications group, already largely shut out of selling its products in the US domestic market, but Trump is also now taking steps to ban the sale of US-made components to Huawei as well. What was once a mere trade skirmish, therefore, appears to be metastasizing into Cold War 2.0.

This creates a conundrum for the Trump administration: Beijing is increasingly viewed by many countries as an economic rival or a security threat to be contained, rather than a collaborative trade partner to be accommodated. But the president’s “America First” trade policy is undermining broader multilateral efforts to contain China because Trump’s incessant focus on reducing his country’s bilateral trade deficit with Beijing means diverting Chinese purchases away from other trade counterparties.

That means, for example, China buying more US cars made on American soil than, say, German ones, more US soybeans than Brazilian, or more US semiconductors than Japanese or South Korean ones, all designed to help reduce the bilateral deficit. This sort of a trade deal, however, is clearly not in the interests of the EU, Brazil, Japan, or Southeast Asia, and is making them averse to collaborating with the United States with regard to any Chinese security concerns they might share (which they do), especially when one considers that the basis for the West’s successful containment strategy against the former Soviet Union was that it was both collaborative and multilateral in scope.

Semiconductors are a perfect case in point to highlight the new contradiction. If Trump bans the export of US-made semis to Huawei (he has now offered a temporary ninety-day waiver), then the latter will naturally gravitate toward buying them from other countries. In fact, the Sino-US trade dispute is just one of many growing points of friction between the US and its traditional allies. Many are increasingly ignoring Trump, and competing for Chinese markets or investment (as the Italians have recently done in response to Beijing’s “Belt and Road Initiative”).

The Sino-US dispute throws up other challenges for the administration: Tariffs are certainly effective as an attention-getting mechanism. But if the goal is ultimately to encourage more jobs at home, they will be ineffective if unaccompanied by a national industrial policy that focuses on American re-industrialization in order to create skilled, high-paying private sector jobs capable of profitably supporting workers with solid middle-class incomes. A corollary is that a national development policy must be geared toward jobs that reflect the needs of the 21st-century economy, rather than nostalgically working to sustain industries that may be headed toward obsolescence, like steel or even fossil fuels.

Many share the president’s belief that a harder line on Chinese trade is necessary. This reflects a growing loss of faith (even among those formerly well-disposed to Beijing) that the country’s market reforms will inevitably lead to multi-party liberal democracy, along with mounting skepticism that free trade and commercial co-dependence can displace military rivalry (a similar historic miscalculation was made before World War One).

But support for the president’s current stance, particularly from Democrats, is conditionally tied to the embrace of a more activist form of state industrial policy to ensure that American workers derive maximum benefit from the reverse engineering of existing “Chimerica” supply chains. And that, argues Professor Michael Lind, “means adequate and permanent production on US soil, not just innovation in America and production elsewhere.” This means some combination of managed trade, along with national industrial policy.

Managed trade, which prioritizes concrete purchases of US goods (as opposed to increased market access or structural changes to China’s economy), is not really new. Ronald Reagan pursued a similar policy against Japan during the 1980s. Nor is the idea of a national economic development strategy particularly contrary to American historical traditions. Since the days of Alexander Hamilton, industrialization and the concomitant role of the state have long been viewed as the joint basis of modern military power and prosperity by both major parties, whether the president was a Republican like Lincoln or Eisenhower, or a Democrat such as FDR or JFK.

It is only with the rise of multinational industry in the past few decades where the notion has taken hold that the state should limit its role in economic development. Borders have come second to measures of growth and corporate profitability. When there has been greater growth potential with policies that go across borders, the policies generally got the green light, even at a cost of eroding America’s homegrown manufacturing base. As industry became even more profitable when it went offshore, the focus for staying on top of the world’s economic food chain shifted – principally in the fields of advanced research in the fields of computing, biology, and of course, military and space.

But Americans themselves often did not experience the benefits of these shifts as more and more industry moved offshore. International Monetary Fund (IMF) and World Bank loans ensured that the developing world would increasingly depend on Western agriculture to feed itself, Western engineering expertise to supply energy infrastructure, and Western finance centers to manage – and leverage – their economies. The muscle memory of state involvement in industry at this point is a matter of bailouts and buyouts. What remains of the old state-level involvement in national economic affairs has evolved into a “Washington Consensus” that engages in a more limited government role: Modest incentives and subsidies to avoid sudden and sharp economic convulsions. A 25-year decline in manufacturing, rather than all at once.

Until the latest disruption on trade, Wall Street and the markets had come to believe Trump would get a trade deal with China that promised increased access to Beijing’s domestic market (for example, the credit card companies and the US rating agencies), but not much in the way of a changed status quo. One of the reasons why the president may have pulled back from this kind of an agreement is that expanding US corporate access to China’s domestic markets actually deepens “Chimerica” integration, rather than disrupting it and bringing much industry back to the United States. American blue-collar workers (a growing Trump constituency) will neither benefit from a “status quo plus” arrangement, nor is that kind of a deal consistent with the growing belief among Trump’s advisers that Beijing constitutes a growing national security threat.

Which leads to one of the new dimensions of this trade war: it is occurring against a backdrop in which long-standing contradictions with regard to trade and national security concerns have finally collided. These tensions are not new, as Michael Lind has observed:

 

Under presidents of both parties, the Pentagon drew up war plans against China while the Commerce Department blessed the offshoring by US-based multinationals of much of America’s industrial base to Chinese soil. This combination of “containment” and “engagement” inspired a name that itself was a contradiction: “congagement”.

 

Trump is attempting to unravel “congagement” via the embrace of a more nationalistic industrial policy. That means returning to “the time-tested and successful Hamiltonian industrial strategy of using whatever means are necessary – tariffs, subsidies, procurement, tax breaks, even overseas-development loans to countries that purchase US manufactured exports – to ensure that strategic industries necessary to US military power are introduced to America or remain here”, as Lind writes.

So with regard to China, this means exporting US goods made on American soil. It, therefore, disrupts existing supply chains. It’s not free trade by any stretch, but the virtue of numerical targets is that they are actually easier to monitor and enforce than vague promises to respect intellectual property or eliminate state subsidies. Under a managed trade framework, if China does not meet its quota of American goods, then Trump could slap on new tariffs. For America’s trade nationalists, this sort of a deal also has the happy byproduct of undermining the multilateral trade framework established by the World Trade Organization because enforcement mechanisms are left in the hands of the two parties to the agreement. With regard to national security considerations, it means preserving domestic manufacturing capacity in “dual-use” industries important in both defense and civilian commerce.

But in resolving one contraction, Trump might well be introducing a new one. While managed trade might well dislocate many existing “Chimerica” supply chains, such disruption would likely come at the economic expense of America’s traditional allies in Europe, Japan, Taiwan, and Korea. If Beijing were to accept specified quotas, it means some other country loses out. Not only will this likely prove unacceptable to China’s non-US trade partners, but it will also further exacerbate widening divisions between the United States and its traditional allies, making coherent economic diplomacy against Beijing less likely (especially against a backdrop of rising national-populist movements that have rendered problematic any idea of a united European response in a protracted rivalry with China). And if it comes against a backdrop of China viewed as a national security threat, Beijing itself has even less incentive to accept such a deal, even if it means risking some short-term economic damage.

There are also economic pitfalls for the United States in embracing such a narrowly nationalistic approach. High-tech “knowledge” industries (for example, biotech, health care, AI, robotics, et cetera) are crucial for future growth prospects. At the same time, growing concerns about climate change risk consigning one of America’s major comparative advantages – namely, its dominance in the fossil fuel industries – to obsolescence, as the rest of the world works to decarbonize their economies. The issue here is that only a few countries matter in these industries (as opposed to, say, resource-based exporters). If the global economy continues to evolve into a series of regional, balkanized competing military-economic blocs in a post-unipolar world, it behooves the United States to be part of the biggest, most advanced of those geo-economic blocs. That becomes harder to do if the EU, Japan, Korea, et al, increasingly view America as an unreliable partner, pursuing narrowly nationalistic policies that damage their own economic interests. Or the United States pursues more preemptive wars of choice, without any degree of international support (for example, Iran).

All of which stands in marked contrast to the post-World War Two period, where the United States consciously made trade-offs that often worked against narrowly nationalistic considerations, but which sustained a coalition that ultimately won the Cold War. For example, it largely tolerated Asia’s mercantilist trade practices in order to secure the region’s cooperation as part of a US-dominated security umbrella (even though the resultant Asian export onslaught proved damaging to a number of American manufacturing interests). Trump has evinced little awareness of, or inclination to pursue, these trade-offs. In fact, “America First” almost makes it impossible to consider them.

In any case, the breakdown in these trade negotiations is yet another sign that we have likely passed the high-water mark of globalization, both in economic terms and also ideologically. We are long past the point of making the naive assumption that the end of the Cold War means a universal embrace of Western liberal capitalist democracy (that is, the “end of history”). Beijing may, in reality, have relatively limited options to retaliate against the trade sanctions imposed by the Trump administration. But it won’t stand still and will seek out new partners to offset this containment as much as possible. At the same time, Trump will find it hard to sustain a multilateral coalition to contain China if the United States continues to pursue narrowly nationalistic managed trade goals that damage its allies. Something will have to give.

https://www.nakedcapitalism.com/2019/05/how-trumps-america-first-trade-strategy-is-accelerating-americas-decline.html

The Great Power Game is On and China is Winning

If America wants to maintain any influence in Asia, it needs to wake up.

by Robert W Merry

The American Conservative (May 22 2019)


President Donald J Trump participates in a bilateral meeting with President Xi Jinping at the Great Hall of the People, Thursday, November 09 2017, in Beijing, People’s Republic of China. (Official White House Photo by Shealah Craighead)

From across the pond come two geopolitical analyses in two top-quality British publications that lay out in stark terms the looming struggle between the United States and China. It isn’t just a trade war, says The Economist in a major cover package. “Trade is not the half of it”, declares the magazine. “The United States and China are contesting every domain, from semiconductors to submarines and from blockbuster films to lunar exploration”. The days when the two superpowers sought a win-win world are gone.

For its own cover, the Financial Times‘ Philip Stephens produced a piece entitled, “Trade is just an opening shot in a wider US-China conflict”. The subhead: “The current standoff is part of a struggle for global pre-eminence”. Writes Stephens:

 

 

The trade narrative is now being subsumed into a much more alarming one. Economics has merged with geopolitics. China, you can hear on almost every corner in sight of the White House and Congress, is not just a dangerous economic competitor but a looming existential threat.

 

Stephens quotes from the so-called National Defense Strategy, entitled “Sharpening the American Military’s Competitive Edge”, released last year by President Donald Trump’s Pentagon. In the South China Sea, for example, says the strategic paper, “China has mounted a rapid military modernization campaign designed to limit US access to the region and provide China a freer hand there”. The broader Chinese goal, warns the Pentagon, is “Indo-Pacific regional hegemony in the near-term and displacement of the United States to achieve global pre-eminence in the future”.

The Economist and Stephens are correct. The trade dispute is merely a small part of a much larger and even more intense geopolitical rivalry that could ignite what Stephens describes as “an altogether hotter war”.

As the Pentagon’s strategic paper posits, China’s overriding foreign policy goal is to squeeze America out of East Asia and force it back to the Hawaiian islands as its forward position in the Pacific. Thus would Hawaii cease to be America’s strategic platform for projecting power into Asia and become merely a defensive position. If this strategic retreat were to happen, it would be one of the most significant developments in international relations since the end of World War Two.

America has been projecting significant power into Asia since the 1890s, when President William McKinley acquired Hawaii through annexation, then seized Guam and the Philippines in the aftermath of the Spanish-American War. For good measure, he cleared the way for the construction of the Panama Canal and continued his predecessors’ robust buildup of the US Navy. President Theodore Roosevelt then pushed the Canal project to actual construction, accelerated the naval buildup, and sent his Great White Fleet around the world as a signal that America had arrived on the global scene – as if anyone could have missed that obvious reality.

With the total victory over Japan in World War Two, America emerged as the hegemon of Asia, with colonies, naval bases, carrier groups, and strategic alliances that made it foolhardy for any nation to even think of challenging our regional dominance. Not even the Vietnam defeat, as psychologically debilitating as that was, could undercut America’s Asian preeminence.

Now China is seeking to position itself to push America back into its own hemisphere. And judging from the language of the National Defense Strategy, America doesn’t intend to be pushed back. This is a clash of wills, with all the makings of an actual military conflict.

But if China represents the greatest potential threat to America’s global position, making an eventual war likely (though not inevitable), why is Washington not acting like it knows this? Why is it engaging in so many silly military capers that undermine its ability to focus attention and resources on the China challenge? While the National Defense Strategy paper suggests that US officials understand the threat, America’s actions reveal an incapacity to grapple with this reality in any concentrated fashion.

Here’s a general idea of what a US foreign policy under Trump might look like if it was based on a clear recognition of the China threat:

Iran: Since the end of the Cold War, the sheer folly of Trump’s Iran policy has been exceeded only by George W Bush’s Iraq invasion. Barack Obama bequeathed to his successor a rare gift in the Iran nuclear deal, which provided an opportunity to direct attention away from Tehran and toward America’s position in East Asia. In no way did it serve America’s national interest to stir up tensions with Iran while the far more ominous China threat loomed. A policy based on realism would have seized that opportunity and used the channels of communication forged through the nuclear deal to establish some kind of accommodation, however wary or tenuous. Instead, America under Trump has created a crisis where none need exist.

Personnel: While the Iran policy might be difficult to reverse, a reversal is imperative. And that means Trump must fire National Security Advisor John Bolton and Secretary of State Mike Pompeo. While their bully boy actions on the global stage seem to mesh with Trump’s own temperament, the president also appears increasingly uncomfortable with the results, particularly with regard to their maximum pressure on Iran, which has brought America closer than ever to actual hostilities. Whether Trump has the subtlety of mind to understand just how destructive these men have been to his broad foreign policy goals is an open question. And Trump certainly deserves plenty of blame for pushing America into a zone of open hostility with Iran. But he can’t extricate himself from his own folly so long as he has Bolton and Pompeo pushing him toward ever more bellicosity in ever more areas of the world. He needs men around him who appreciate just how wrongheaded American foreign policy has been in the post-Cold War era – men such as retired Army Colonel Douglas MacGregor and former Virginia senator Jim Webb. Bolton and Pompeo – out!

Russia: Of all the developments percolating in the world today, none is more ominous than the growing prospect of an anti-American alliance involving Russia, China, Turkey, and Iran. Yet such an alliance is in the works, largely as a result of America’s inability to forge a foreign policy that recognizes the legitimate geopolitical interests of other nations. If the United States is to maintain its position in Asia, this trend must be reversed.

The key is Russia, largely by dint of its geopolitical position in the Eurasian heartland. If China’s global rise is to be thwarted, it must be prevented from gaining dominance over Eurasia. Only Russia can do that. But Russia has no incentive to act because it feels threatened by the West. Nato has pushed eastward right up to its borders and threatened to incorporate regions that have been part of Russia’s sphere of influence – and its defense perimeter – for centuries.

Given the trends that are plainly discernible in the Far East, the West must normalize relations with Russia. That means providing assurances that Nato expansion is over for good. It means the West recognizing that Georgia, Belarus, and, yes, Ukraine are within Russia’s natural zone of influence. They will never be invited into Nato, and any solution to the Ukraine conundrum will have to accommodate Russian interests. Further, the West must get over Russia’s annexation of the Crimean peninsula. It is a fait accompli – and one that any other nation, including America, would have executed in similar circumstances.

Would Russian President Vladimir Putin spurn these overtures and maintain a posture of bellicosity toward the West? We can’t be sure, but that certainly wouldn’t be in his interest. And how will we ever know when it’s never been tried? We now understand that allegations of Trump’s campaign colluding with Russia were meritless, so it’s time to determine the true nature and extent of Putin’s strategic aims. That’s impossible so long as America maintains its sanctions and general bellicosity.

Nato: Trump was right during the 2016 presidential campaign when he said that Nato was obsolete. He later dialed back on that, but any neutral observer can see that the circumstances that spawned Nato as an imperative of Western survival no longer exist. The Soviet Union is gone, and the 1.3 million Russian and client state troops it placed on Western Europe’s doorstep are gone as well.

So what kind of threat could Russia pose to Europe and the West? The European Union’s GDP is more than twelve times that of Russia’s, while Russia’s per capita GDP is only a fourth of Europe’s. The Russian population is 144.5 million to Europe’s 512 million. Does anyone seriously think that Russia poses a serious threat to Europe or that Europe needs the American big brother for survival, as in the immediate postwar years? Of course not. This is just a ruse for the maintenance of the status quo – Europe as subservient to America, the Russian bear as menacing grizzly, America as protective slayer in the event of an attack.

This is all ridiculous. Nato shouldn’t be abolished. It should be reconfigured for the realities of today. It should be European-led, not American-led. It should pay for its own defense entirely, whatever that might be (and Europe’s calculation of that will inform us as to its true assessment of the Russian threat). America should be its primary ally, but not committed to intervene whenever a tiny European nation feels threatened. Nato’s Article 5, committing all alliance nations to the defense of any other when attacked, should be scrapped in favor of language that calls for US intervention only in the event of a true threat to Western Civilization itself.

And while a European-led Nato would find it difficult to pull back from its forward eastern positions after adding so many nations in the post-Cold War era, it should extend assurances to Russia that it has no intention of acting provocatively – absent, of course, any Russian provocations.

The Middle East: The United States should reduce its footprint in the region on a major scale. It should get out of Afghanistan, with assurances to the Taliban that it will allow that country to go its own way, irrespective of the outcome, so long as it doesn’t pose a threat to the United States or its vital interests. US troops should be removed from Syria, and America should stop supporting Saudi Arabia’s nasty war in Yemen. We should make clear to Israel and the world that the Jewish state is a major US ally and will be protected whenever it is truly threatened. But we should also emphasize that we won’t seek through military means to alter the regional balance of power based on mere perceptions of potential future threats to countries in the region, even allies. The United States won’t get drawn into regional wars unrelated to its own vital interests.

Far East: Once the other regional decks are cleared, America must turn its attention to Asia. The first question: do we wish to maintain our current position there, or can we accept China’s rise even if it means a US retreat or partial retreat from the region? If a retreat is deemed acceptable, then America should secure the best terms possible over a long period of tough and guileful negotiations. But if we decide to maintain regional dominance, then China will have to be isolated and deterred. That will mean a long period of economic tension and even economic warfare, confrontations over China’s extravagant claims of sovereignty in the South China Sea and elsewhere, strong US alliances with other Asian nations nurtured through deft and measured diplomacy, soaring technological superiority, and a continual upper hand in any arms race.

In this scenario, can war be averted? History suggests that may not be likely. But either way, America won’t remain an Asian power if it allows itself to be pinned down in multiple nonstrategic spats and adventures around the world. Asia is today’s Great Game and China is winning. That won’t be reversed unless America starts playing.

_____

Robert W Merry, longtime Washington journalist and publishing executive, is the author most recently of President McKinley: Architect of the American Century (2017).

Related Articles:

* https://www.theamericanconservative.com/articles/china-has-already-lost-the-trade-war/

* https://www.theamericanconservative.com/articles/china-isnt-an-enemy-and-hawks-shouldnt-turn-it-into-one/

https://www.theamericanconservative.com/articles/the-great-power-game-is-on-and-china-is-winning/

Zen and the Art of Modern Money (Part 2)

by J D Alt

New Economic Perspectives (May 07 2019)

https://www.nakedcapitalism.com (May 13 2019)

FIRST: Prime the Fuel-Pumps

As it stands, our diagram-machine has no fuel (“money”) in it, so it can’t operate. We could go through an exercise to imagine how it could prime itself in order to begin operations. But this would lead to other topics and considerations which would only distract us from our present goal – which is to simply understand HOW the diagram-machine operates – and how, and when, in the course of its operations, it creates money. To move things along, we’ll simply (and arbitrarily) populate the machine with some money to get it started. We’ll assign to each of the eight “accounts” of our diagram-machine a value of ten dollars:

* $10 worth of Reserves (Rs) in Bank#1 Reserve account $10 worth of future Reserves (fR) in Bank#2 Reserve account

* $10 worth of Reserves (Rs) in Treasury Reserve account

* $10 worth of Promissory Notes (Pn) in the Federal Reserve (FED) account

* $10 worth of bank-dollars (Bd) in private bank account#1

* $10 worth of bank-dollars (Bd) in private bank account#2

* $10 worth of Promissory Notes (Pn) for bank#1

* $10 worth of Promissory Notes (Pn) for bank#2

You’ll notice there seem to be a lot of different “identities” the ten dollars can take: “Reserves”, “bank-dollars”, “promissory notes”, et cetera. So, we need to take a quick moment to understand the different flavors of the fuel our machine will be running on.

Here’s the menu:

1. $10 worth of Reserves represents $10 worth of what the US government will accept as payment for taxes or other debts owed to the federal government. This, in fact, is what you might consider “real” money. (Sorry for the odd name; someone else decided to call them “Reserves”.) The other flavors are all derivatives of Reserve dollars. While the other flavors play crucial roles in the operation of the machine, they must always be converted to Reserves in order to make the one payment every citizen and business is required, by law, to make on a recurring basis – payment of federal taxes.

2. $10 worth of future Reserves are just that: Reserves that the government promises to create at some specific point in the future. These are commonly referred to as “treasury bonds”. While they are virtually identical to corporate or municipal bonds, they are distinctly different in one crucial characteristic (explained in a sidebar on page __). This crucial distinction makes it more appropriate – and less confusing – to simply think of treasury bonds as “future Reserves”.

3. $10 worth of bank-dollars are claims on $10 worth of Reserves held in the Bank#1 or Bank#2 Reserve accounts at the Central Bank. (Think of bank-dollars as being “claim-checks” for “real” dollars that are held at the Central Bank. Since the claim is guaranteed, operationally there is little distinction between the claim-check and the “real” dollar it makes claim to. They are, in effect, interchangeable.)

4. $10 worth of Promissory Notes are legal promises that $10 bank-dollars (or Reserves if it’s a note to the FED) – plus an interest premium – will be exchanged for the Promissory Notes at a specific time in the future. When that promise is fulfilled, the Promissory Note is cancelled.

All the “dollars” in the machine, then, are either Reserves, or claims on Reserves, or promises to pay Reserves (or claims on Reserves) at some point in the future. If you’re wondering where “cash” dollars – those things we all think of as “money” – fit in, please read the side-bar on page__. (Short answer: Federal Reserve Notes, that is, “cash” dollars, are simply another form of claim on Reserves at the Central Bank. In that sense, they are no different than bank-dollars, and they are not something that plays a unique role in the operation of our machine.)

Those are the “fuel-flavors” our Diagram-machine is going to run on. Now we’re finally ready for our first machine operation.

OPERATION #1 – A Simple Transaction in Private Commerce

STEP 1: Private bank #1 makes a loan.

* The person with bank account#1 gives Bank#1 a promissory note promising to pay the bank $20 (with five percent interest) at some point in the future. In exchange, Bank#1 credits to bank account#1 $20 bank-dollars, increasing that account to $30 bank-dollars. Bank#1 records $21 worth of new Promissory Notes ($20 + five percent interest=$21).

* The bank-dollars are, in effect, the bank’s promissory notes back to the borrower. They promise two things: First, Bank#1 will accept its own bank-dollars as repayment for the loan; second, the bank-dollar will be recognized as a legal claim on the Reserves Bank#1 holds in its Reserve account at the Central Bank.

* PLEASE NOTE: Our machine has just “created” $20 in fuel! The owner of bank account#1 is now ready to purchase goods and services worth up to
$30.

STEP 2: A transaction occurs in the Private Combustion Chamber.

The person with bank account#1 purchases a new pair of shoes for $25. They write a check on their account#1 and exchange it with the shoe store for the shoes.

* Bank account #2 happens to be the shoe store’s account. The shoe store deposits the check it received for the shoes in bank account#2.

* The owner of bank account#1 walks home with a new pair of shoes. This is the consumption which is the ultimate purpose of our Diagram-machine! But the machine, itself, isn’t quite finished with this transaction:

STEP 3: Check-clearing and Reserve allocations at the Central Bank

* This is the first “pay-attention-to” moment in the operation of the Diagram-machine: The $25 check deposited in bank account#2 is a claim on the Reserves held in the Reserve account of Bank #1. This causes the following operations to occur at the Central Bank:

* At the end of the business day, the $25 check for the shoes is presented, by Bank#2, at the Central Bank to be “cleared”. Specifically (and operationally) this means that the claim the check represents on the Reserves held in Bank#1’s Reserve account shall be exercised. This happens, in fact, automatically:

* Bank#1 Reserve account is debited $25, Bank#2 Reserve account is credited $25, and bank account #2 is credited $25 bank-dollars. The check has now “cleared”, and the transaction appears to be complete – but not quite!

To see why our diagram-machine isn’t quite finished with OPERATION #1, we must take note that our fuel flow-meter is telling us Bank#1 Reserve account is minus $15Rs! It didn’t have $25 Reserves to transfer to Bank#2 Reserve account!

This is our second “pay-attention-to” moment: A bank’s Reserve account at the Central Bank cannot be negative! Banks are required, by law, to maintain adequate Reserves in their Central Bank account to handle the “clearing” demands that might come due at the end of each business day. Something else, then, must happen in our Diagram-machine to correct this “impossible” situation – or else our machine will seize up. Fortunately, the machine is designed to manage and accommodate this very situation. Watch, now, what it does:

STEP #4: The FED loans Reserves to Bank#1

* Bank#1 needs to borrow Reserves in order to “clear” the $25 check. Who does it borrow Reserves from? Normally, it would borrow Reserves from another bank with excess Reserves. (Reserves, it should be noted, do not pay interest – or only very low interest. They just sit there, like lumps on a log, in the various Reserve accounts. Banks with excess Reserves in their account at the Central Bank, therefore, like to lend them out to earn interest and add to their profits.) Borrowing from another bank’s excess Reserves, however, is not always possible – as is the case with the present circumstances of our Diagram-machine.

* The lender of last-resort is the FED. Ultimately, the FED’s primary job is to ensure that all the checks in the banking system “clear” at the end of each business day. In our present case, the FED credits Bank#1 Reserve account with $25 Reserves, and accepts, in exchange from Bank#1, a Promissory Note promising to pay the FED $25 Reserves + two percent interest at some point in the future.

* Now, here is the third “pay-attention-to” moment: Where does the FED get the Reserves it loans to Bank#1? We should note that the FED has no Reserves in its account – it has only Promissory Notes. So where do the Reserve s it loans to Bank#1 come from? ANSWER: the FED simply “issues” them – because that is what it was specifically established and authorized to do. The FED “issues” the new Reserves out of thin air in exchange for Bank#1’s Promissory Note.

PLEASE NOTE: our machine has just created more new fuel! This time $25 new Reserve dollars. Our first operation of the Diagram-machine is now (finally) complete. But let’s not forget what was really accomplished by all this accounting: Someone in America (in this case the owner of bank account#1) has obtained a new pair of shoes! That’s what the operation was all about.

Summarizing OPERATION #1

Let’s stop here, before continuing, and consider what we’ve just observed. First, our diagram-machine has facilitated a transaction in the Private Combustion Chamber resulting in the consumption of a new pair of shoes. What we’ve observed, however, is that the “real” financial transaction doesn’t take place at the shoe store. It takes place, instead, at the Central Bank when Reserves (the “real” US dollars) are claimed and then debited and credited between Reserve accounts. This exchange takes place entirely within the Central Bank and “mirrors” the exchange that took place – with bank-dollars – at the shoe store.

Also note that Reserves, themselves, never leave the Central Bank! They are debited and credited between different accounts at the Central Bank, but they never leave its confines. The Central Bank, in effect, is a “score-keeper” of the exchanges that are going on in the outside world and Reserves are the “points” that keep the score! If the players in the outside game decide to run up the score (as the owner of bank account#1 did when it signed the $20 Promissory Note) the Central Bank operations automatically create the necessary “points” to keep the game going.

Second, we’ve observed that when we began our operation, there was not enough fuel (money) in either of the bank accounts (or both together) to buy the shoes. As we just noted above, the machine, itself, produced the necessary dollars to make the transaction happen.

The Reserves the FED loaned to Bank#1 were new Reserves it created out of thin air. When the FED needs to produce Reserves, it does not withdraw them from an “account”, it simply issues them. This is precisely what it was designed and empowered to do.

What we have observed in OPERATION #1, then, is that the American consumer decided a new pair of shoes was needed – and our diagram-machine produced the dollars that enabled the shoe-consumption transaction to take place. Specifically, the FED produced the new Reserves that enabled the “clearing” process to complete itself. We might stop here and ask ourselves: Is this what people mean when they talk about “printing money”?

The FED, in the operation of our diagram-machine, has created $25 Reserves which previously did not exist. Is that good or bad? Is that creating a problem, or solving a problem? Is there even a problem? Is the diagram-machine simply operating as it was intended – or has some travesty just occurred? These questions will become even more important in our next diagram-machine operation involving the Public Combustion Chamber.

http://neweconomicperspectives.org/2019/05/zen-and-the-art-of-modern-money-part-2.html

https://www.nakedcapitalism.com/2019/05/zen-and-the-art-of-modern-money-part-2-mmt.html

China Raises Threat of Rare-Earths Cutoff to US

Beijing could slam every corner of the American economy, from oil refineries to wind turbines to jet engines, by banning exports of crucial minerals.

by Keith Johnson and Elias Groll

https://foreignpolicy.com (May 21 2019)

With a simple visit to an obscure factory on Monday, Chinese President Xi Jinping has raised the specter that China could potentially cut off supplies of critical materials needed by huge swaths of the US economy, underscoring growing concerns that large-scale economic integration is boomeranging and becoming a geopolitical weapon.

With the US-China trade war intensifying, Chinese state media last week began floating the idea of banning exports of rare-earth elements to the United States, one of several possible Chinese responses to US President Donald Trump’s decision to jack up tariffs on hundreds of billions of dollars’ worth of Chinese goods and blacklist telecoms maker Huawei.

US oil refiners rely on rare-earth imports as catalysts to turn crude oil into gasoline and jet fuel. Permanent magnets, which use four different rare-earth elements to differing degrees, pop up in everything including earbuds, wind turbines, and electric cars. And China dominates their production.

“It would affect everything – autos, renewable energy, defense, and technology”, said Ryan Castilloux, the founding director of Adamas Intelligence, a strategic metals consultancy. China supplies about eighty percent of the rare-earth elements imported by the United States, which are used in oil refining, batteries, consumer electronics, defense, and more.

Those concerns became a lot more tangible this week when Xi, accompanied by his point man for US trade talks, visited a facility in the heart of China’s rare-earths industrial complex. Xi called for a new “Long March”, a reference to one of the founding epics of the Chinese Communist Party, in its economic war with the United States. “There is always some degree of misinterpretation, but with the timing [of Xi’s visit] it’s our view that the optics suggest what they suggest, and that it is indeed” a veiled threat, Castilloux said.

This wouldn’t be the first time China has used its dominant position in rare earths as geopolitical leverage. In 2010, China sharply limited rare-earth exports to Japan, a big consumer, while the two countries were sparring over disputed islands. The embargo won China some short-term victories but also drove other countries to reassess and reduce their reliance on critical materials that Beijing controls.

“One takeaway from the Japan embargo is that China’s reputation as a stable producer suffered”, said Sagatom Saha, an independent energy policy analyst who’s studied the issue. “I’d be surprised if there were an outright embargo. It would be a drastic measure that would permanently raise alarm bells in global national security circles to achieve a small goal to which it could apply other tools, or even possibly wait out, given Trump’s fickleness.”

But if China does reach for what Castilloux calls the “nuclear option”, it would hammer big chunks of the US economy, though the exact magnitude of such a move is difficult to estimate. The mere threat of China turning off the tap of critical industrial materials highlights a vulnerability that is increasingly worrying analysts and policymakers in Washington, Beijing, and other capitals. Globalized supply chains offer flexibility and lower costs for consumers of a wide range of products. At the same time, the central position of the US dollar and US financial system has streamlined trade and fueled growth. But at times of geopolitical tension, those same efficiencies can suddenly become deadly vulnerabilities – for all countries.

In the last twenty years, the United States has used its dominance of the global financial system to punish its adversaries by blocking them from carrying out transactions with US banks, even if that means browbeating allies in the process. Now, with the prohibition of US firms doing business with Huawei and other Chinese firms, Washington is testing whether it can use critical American technology used by companies the world over in a similar fashion.

Henry Farrell, a political scientist at George Washington University, calls this “weaponized interdependence”. Globalization has created global economic networks of engineering centers, manufacturers, and suppliers, and countries are now examining these networks to find their weak points and exploit them for geostrategic gain.

Washington’s move against Huawei marks “the opening of a new and much more dramatic stage” in using these tools as part of a conflict that has been brewing between China and the United States for decades, Farrell said.

But whether it’s Chinese threats of withholding critical raw materials or US bans on technology exports, the strategy is fraught with uncertainty and risks. Huawei spends an estimated $11 billion every year on goods from US companies, and it is unclear whether the Trump administration will remain committed to a policy with severe knock-on effects for major American firms such as Qualcomm, Broadcom, and Google. That’s one reason the United States has allowed a ninety-day window for US companies to adjust to the new rules – a window that it may extend.

But just as the US moves, meant to punish China, could damage American firms, they could also accelerate the very Chinese policies the Trump administration has sought to derail. China has high-profile plans to increase domestic semiconductor and high-tech manufacturing, and the conflict over Huawei is likely to accelerate those plans, with the possibility of more rapidly eroding US dominance of the global chip market.

“China is looking to be more self-sufficient, or at least less reliant on US components”, said Dexter Thillien, an analyst at Fitch Solutions.

China’s stranglehold on rare-earth elements and other critical minerals and US leverage of its dominance of crucial sectors are hardly new. Countless countries have used a dominant position to wield outsize power in the past.

Treeless ancient Egypt was dependent on Levantine cedar for all the pharaoh’s ships. Middle East Bronze-age societies were beholden to middlemen who could supply tin from as far away as Britain to make bronze weapons. British forces in the US Revolution found themselves suddenly cut off from Spanish-controlled sources of antimalarial quinine, with disastrous effects. In World War One, with demand for explosives skyrocketing, Germany found itself cut off from vital supplies of Chilean nitrates. And, most famously, Japan’s dependence on US oil exports (and the eventual US embargo on sales to Japan) led to Tokyo’s attack on Pearl Harbor and lunge to Southeast Asia in late 1941.

But China’s control of rare-earth processing, as well as its dominant position in other critical minerals like cobalt (used in batteries), gives it potentially even greater leverage than those countries enjoyed in the past. The one mine in the United States producing rare-earth minerals is itself reliant on China for processing the material it pulls from the ground into usable end products.

If China were to take the drastic step of banning or limiting exports of rare-earth elements and advanced materials, there’s not a whole lot the United States could do in the short term. For some imports, especially for permanent magnets, there are alternative suppliers in Australia. But even they face challenges to keep doing business and could lose their ability to process the raw materials so needed by the US economy.

“Then the Plan B for the US would no longer be viable – that’s where it finds itself between a rock and a hard place” with the China pressure, Castilloux said.

In the longer term, any Chinese move to restrict access to critical materials would likely accelerate nascent US efforts to bolster its own economic independence. In late 2017, the Trump administration jump-started efforts to ameliorate US reliance on imported critical minerals. This month, Congress jumped on board, with a bipartisan bill that could help spur mining of US rare-earth elements and other critical minerals, a first step toward addressing a long-recognized weakness.

“A lot of people are waking up to the China challenge. Global interdependence is a strength, but is also proving to be a weakness”, said Ashley Feng of the Center for a New American Security. “Lawmakers are asking a lot more questions about how to reduce that economic interdependence, and I expect to see some concrete action”.

https://foreignpolicy.com/2019/05/21/china-raises-threat-of-rare-earth-mineral-cutoff-to-us/